HMRC have recently introduced changes to the basis period of taxation for certain businesses. Buckle up and grab a mug of something hot, because we’re going to dive into the details of how basis period reform could affect your business.
Basis period reform will only impact specific types of businesses
Already having started to come into effect on 6 April 2023, the changes apply to…
- Unincorporated businesses
- Limited Liability Partnerships (LLPs)
- Sole traders
…that have a financial year end that isn’t between 31 March and 5 April 2023.
In other words, those who currently don’t prepare their annual accounts to a reference date between that time.
Although Making Tax Digital (MTD) has been pushed back to 2026, this reform has already been implemented
From April 2024, these types of businesses will be taxed on profits generated between 6 April to 5 April the following year. No matter when their year end is.
HMRC will treat year end dates that fall between 31 March and 5 April as if they fall at the end of the tax year.
To understand what the changes mean, let’s first examine the previous rules
Under the previous rules, the affected types of businesses paid tax based on their taxable profits made in the 12-month accounting period ending in the tax year.
For a business not in its first accounting period:
Example
If a business prepared its accounts for the 12 months ending 31 December 2022, the profits from this period (after adjustments) would be taxed on the individual in their tax return for the 2022/23 tax year.
For a business in its first accounting period:
Different rules apply to individuals in the first tax year their business starts to trade. The starting date is usually taken as the date the partners or members are admitted into the partnership or LLP, or for a sole trader simply the date the trade started.
In their first tax year of trade, the individual will be taxed on their profits from the date of starting to trade up until the end of that tax year (5 April).
Example
If a new partner joined on 1 January 2021 where the accounting year end was 31 December 2021, the first period they were taxed was in the 2020/21 tax year. Their income would be their profits from 1 January 2021 to 5 April 2021.
The next tax year 2021/22, they are taxed on the profit from the first 12 months. In other words, from 1 January to 31 December 2021.
In this scenario, there’s what’s known as “overlap profits” – a portion of profits taxed twice in these years, in this example from 1 January 2021 to 5 April 2021. Those overlap profits are then carried forward until the business is sold or ceases trading, or the year end is changed, when the partner would get a tax deduction for them.
2023/24 will be a transition year for basis period reform
During this tax year, individuals will be taxed on a long period of accounting ending 5 April 2024, including all untaxed accounting profits generated up to this date.
Relief will be granted to any overlap profits generated under the previous basis period rules.
Example
If an ongoing business (not in its first year of trading) has an accounting year end of 31 December, its 2023/24 tax return will need to include profits for the 12 months ending 31 December 2023 – plus profits for the three months ending 5 April 2024.
There are transitional profit-spreading rules
These rules allow the payment of tax liability generated from transitional period profits to be spread over five tax years, starting the year of transition.
The extra tax due on these profits won’t be paid entirely in the 2023/4 tax year, which should ease any pressure on your business’s cash flow.
Example
| Year end 30 September 2023 | £100,000 |
| Period 1 October 2023 to 31 March 2024 | £50,000 |
| Total | £150,000 |
| Less: overlap profits brought forward | (£20,000) |
| Taxable profits | £130,000 |
Under the previous rules, the taxable profits for the tax year 2023/24 would have been £100,000.
With the new reform, the taxable profit for the 2023/24 tax year is £130,000. So a significant increase to taxable profits and therefore to the tax bill.
The good news is the transitional rules allow the excess profits of £30,000 to be spread across five tax years. In this example that means an additional £6,000 taxable over five years from 2023/4 to 2027/8.
Affected businesses will be taxed on profits generated between the start and end of the tax year
From 2024/25, all unincorporated businesses will need to pay tax on profits from 6 April to 5 April the following year. This will be applicable regardless of the year end the business normally adheres to when preparing its accounts.
Note that HMRC will allow a year end that falls between 31 March and 5 April. This is treated as if it falls at the end of the tax year. Most of our unincorporated clients have a year end of 31 March so won’t be impacted by basis period reform.
Example
If a business has an accounting year end of 31 December, it will need to allocate profits from two accounting periods to fit into the 6 April to 5 April time period.
Estimated profits will have to be included if the accounts haven’t been finalised before the tax return filing deadline.
Changing your accounting year end could benefit your business
With the recent reforms disrupting the (somewhat) calm tax waters, it’s a good time to look at when your accounting year end falls and whether it’s the best choice for your business.
If it’s not, changing it to 31 March or 5 April could help protect your cash flow.
Most unincorporated businesses choose to align their year end with the tax year, for a couple of reasons:
- A different year end is less intuitive when trying to understand your potential tax bill
- Financial accounts will have to be prepared alongside estimated figures up to 31 March or 5 April
In short, aligning your accounting year end with the tax year could save money and avoid extra admin created by the new rules.
If all those details seem overwhelming, we’re here to help
There’s a lot to get your head around. If you feel like it’s time to swap your cup of tea for a glass of wine, we don’t blame you.
Each business’s circumstances are different, and an accounting year end that benefits one business might not be best for another.
We’re here to act as your sounding board to help with the tricky stuff. If you’d like a friendly, supportive chat about how these changes will apply to your business, fill in our form and we’ll be in touch.
